The option pricing models that are widely used today to analyze the markets and discover profit value are largely attributable financial pioneers Fisher Black, Myron Scholes, and Robert Merton. The three men used financial principles and involved mathematical formulas to derive a system capable of determining an option’s value during any moment of its existence. The system was eventually called the Black-Scholes system and earned both Scholes and Merton the Nobel Prize in Economics for the year 1997 (Fisher died before the coveted award was presented). Other option pricing models have emerged, but they are all based on the Black-Scholes model.

So, how do you calculate an option’s speculative price? There are basically five items to consider:

• Share price of underlying asset
• Option’s expiration date
• Strike price
• Current interest rate
• Volatility

With the exception of volatility, all of these items are either static or easy to determine. You can search any stock search and find its current share price. An option is associated with a particular expiration date and strike price. You can easily Google for the current interest rate. The only way to determine volatility, which refers to the stability of an option, is to use a pricing model. What the pricing model will do is analyze an option’s level of volatility that you can then use to determine if the option will realize a profit before its expiration date. In simple terms, a high volatility means that profit is likely and a low volatility means that profit is unlikely.

Another function that a pricing model performs is to calculate the Greeks, specifically the Delta, Gamma, Vega, and Theta. The Greeks represent market factors that can affect an option. By using a pricing model to apply a specific Greek, you can determine a likely outcome of an option.

Quick Pricing Formula

The Black-Scholes options pricing model is the best method for determining the value of an option. However, it does require some time that you may not always possess. If you need a result fast, the Quick Pricing Formula is a reliable solution for analyzing the outcome of an option.

Instead of five components, the Quick Pricing Formula uses three: volatility, time ratio, and base price.

Price = (0.4 x Volatility x Square Root(Time Ratio)) x Base Price

We have previously discussed volatility. Time Ratio is a new concept. Time Ratio refers to how much remains before an option expires (in days, month, years). The Quick Pricing Form takes the square root of Time Ratio to achieve a numerical value.